Links of Interest (2011-07-12)

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1. De and Iacovone on Did NAFTA increase productivity?. “The results show that the North American Free Trade Agreement stimulated the productivity of Mexican plants via: (1) an increase in import competition and (2) a positive effect on access to imported intermediate inputs. However, the impact of trade reforms was not identical for all integrated firms, with fully integrated firms (i.e. firms simultaneously exporting and importing) benefiting more than other integrated firms.” Here is more on NAFTA.

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2. Li, Mengistae and Xu diagnose development bottlenecks in China and India. “The analysis finds that China has better infrastructure, more skilled workers, and more labor-hiring flexibility than India, but a worse access to finance and higher regulatory burden. Infrastructure appears to be a key constraint for India: it lags significantly behind China, yet it has important indirect effects for the effectiveness of labor flexibility. Labor flexibility is also likely a major constraint for India, as evident in the predominance of small firms, the importance of firm size in accounting for India's disadvantage in productivity, and the complementarity of proxies of labor flexibility with infrastructure and access to finance. Interestingly, regulatory uncertainty has adverse effects in India but not in China.”

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3. Khanal and Satyal weigh in the socio-economic impact of remittances. Their basic argument is that the failure to find jobs (or create due to laxity in implementing such policies) is leading to an exodus of workers to foreign employment destinations. They also argue that remittances have not helped in “reducing poverty”. I wonder how they define it because the latest study on remittances find that it has helped to reduce absolute poverty.

The increase in imports, consumption, aiding real estate and housing bubbles, and change in labor supply of returnees are some of the concerns. Remittances have done both good and bad to the economy, both at the household and macro levels. It in itself is not bad. When there are few existing chances of employment in economy and chances of finding new are very slim, exodus of workers is normal. Systematizing such supply of labor by giving training and helping them find good employment opportunities, if they like, elsewhere is not a bad policy in the short run. In the long run, retaining the required at home is crucial. For that, channeling remittances in productive usages as opposed to consumption of imported goods is essential. Nepali policymakers have failed on this front. And, that is the danger.

We are seeing symptoms of Dutch Disease in the economy. Letting it not be a Dutch Disease itself requires a both short run and long run policies. The former is due to our compulsion as we can’t just chock the flow of money just to check ‘brain drain’ (or ‘brain gain’?). People will go anyway if there are no opportunities at home or the opportunities elsewhere are higher than at home. Systematizing this process (though a second best option) in the short term is good for the nation. The first best option is creating opportunities at home, which can be done gradually. Work should be started on both fronts. Note that even if there are opportunities at home, people still do migrate.

Here is Santosh Pokharel’s take on why remitters are drifting away form using formal remittance channels (high fees and lack of awareness).

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4. Bernstein on Obama’s hat tip to Keynes. “The President signaled an understanding of the effectiveness of stimulus along with the need for more of it.” Krugman on “He’s just not that into you”.

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5. Campos and Nugent on why the global financial crisis has been wasted.

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6. Ezekwesili on the birth of the Republic of South Sudan.

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7. Nepal’s budget for FY 2011-2012: The upcoming budget in a new format to make Nepal’s accounting system compatible with international accounting. Any expenditure under the grants and subsidies heading will be considered as recurrent expenditure. Therefore, grants and subsidies that currently fall under capital expenditure will be moved to recurrent expenditure. Revenue and grant will be shown in the income part instead of revenue. Under this heading, tax, other revenues and foreign grants will be included. The principal refund that is currently shown in the revenue heading will be moved to financing part. The principal payment will be moved from the expenditure part.The new budget will have loan investments, capital investment, foreign loans and borrowing under the financing heading. It will be shown under this heading after adjusting refund of loan investment and principal payment of foreign and domestic borrowing. Meanwhile, peace, social inclusion and infrastructure will be the priority (so they say!). Civil servants salary to be hiked by at least 20 percent. Earlier, I argued for why the public sector salary should be increased. Here is my take on Nepal’s policies and programs for FY 2011-2012.

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Female reservation and political outcomes

Deininger, Jin, Nagarajan and Fang (2011) find that in rural India gender quotas led to decline in quality and negative impact on service delivery, it nevertheless have positive impact on women’s political participation, political accountability, and willingness to contribute to public goods. The abstract of the paper is as follows:

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Although many studies have explored the impacts of political quotas for females, often with ambiguous results, the underlying mechanisms and long-term effects have received little attention. This paper uses nationwide data from India spanning a 15-year period to explore how reservations affect leader qualifications, service delivery, political participation, local accountability, and individuals’ willingness to contribute to public goods. Although leader quality declines and impacts on service quality are often negative, gender quotas are shown to increase the level and quality of women's political participation, the ability to hold leaders to account, and the willingness to contribute to public goods. Key effects persist beyond the reserved period and impacts on females often materialize only with a lag.

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May be the Nepalese leaders and policymakers, who are ever-active in reserving quotas in all sectors for women, could learn something from the findings of this study.

Misplaced export incentives in Nepal

My latest piece is about why cash incentive for exporters will not work when the binding constraints to exports growth and revenue are related to supply-side and slacking productive capacities.

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Misplaced export incentives

Against the backdrop of declining exports and increasing imports, leading to widening trade deficit, last fiscal year the then Finance Minister Surendra Pandey announced export incentives in the form of cash returns to exporters that met certain value addition criteria. Though it initially filled in excitement in the export-oriented sector, the ill conceived program was not implemented due to lack of appropriate regulations. Now, without much consideration if such incentives will in fact work, the government is all set to give continuity to the same program and implement it through the upcoming budget.

Before such incentives are rolled out a pertinent question to ask is: How effective and optimal cash incentives will be in promoting Nepali exports? It seems cash incentives will not have much impact in our exports, encourage entrepreneurship and expand the exports basket. Instead, much more substantive impact might be seen if alternative incentive measures are implemented at pretty much the same cost.

During the budget for fiscal year 2010/11, cash incentives totaling two to four percent, based on value addition, of total exports value earned by exporting items to destinations except India was announced to boost exports and increase foreign exchange. Specifically, exporters of goods with up to 30-50 percent value addition were supposed to get 2 percent of total export revenue as cash incentive. Similarly, that with 50-80 percent value addition were supposed to get 3 percent cash incentive and for over 80 percent value addition the cash incentive was 4 percent of total exports revenue. The government allocated Rs 240 million for this program. Now, the Ministry of Commerce and Supplies (MoCS) has asked the government to provide such incentive to exporters exporting goods to India as well. Furthermore, it has even asked cash incentives as high as five percent of total exports revenue on products identified as having high “export potential” in Nepal Trade Integration Strategy (NTIS) 2010.

Export incentives (monetary, tax or legal) are given with the hope that exports and foreign reserves will increase and economic activities pick up in the export-oriented sectors, mainly manufacturing sector. Currently, both exports and manufacturing sectors are performing poorly. Exports and manufacturing are around 15 percent and 7 percent of GDP respectively. Any incentive geared toward increasing exports and its competitiveness sounds fine. But, these incentives should help in enhancing productive capacity as well and in making exports sustainable, especially after such incentives are pulled back.

For now, doling out cash to exporters that export the same items that fill up much of our exports basket is not a smart move and will neither make our exports competitive nor increase exports revenue as envisioned. Most of the items in the basket are losing competitiveness, both in terms of cost and quality. In our export-oriented firms, giving cash incentives will not decrease cost of production and make products cost competitive in the international market. Most of the allocated amount will be claimed by garment, textile and carpet manufacturers, whose exports are losing competitiveness. There will hardly be any value addition above the existing level in these products. Hence, in terms of enhancing productive capacities and competitiveness of the existing export-oriented firms, the scheme’s impact will almost be nil. Furthermore, there will be little change in terms of new exporters and new export items added to the exports basket.

Export incentive packages that increase productive capacity and address binding constraints to exports growth work more often than simply doling out cash based on certain value addition criteria. The same amount of money can be used to construct roads up to manufacturing plants or to provide credit and concessional loans to emerging entrepreneurs or to subsidize insurance premium during transportation of goods to the nearest port in India or to construct the much needed special economic zones. These measures will help enhance our exports and add to productive capacities more than the cash incentives.

It would also be wise to design such incentive packages so that they help in reducing time and cost incurred while exporting goods from Nepal. The Nepali exporters still face comparatively more hurdles in exporting goods than our neighbors in the region, giving them cost and time advantage. In trading across borders, which is one of the indicators of Doing Business ranking, Nepal is ranked 164 out of 183 countries. Moreover, Nepali exporters have to produce at least 9 documents and takes 41 days to process them before they are cleared for export. These numbers are one of the highest in the region. Furthermore, Nepal has one of the worst logistics related to exports and ranks 147 out of 155 countries in the latest Logistics Performance Index ranking. Nepal’s logistics ranking is worse than that of Afghanistan. Cash incentives to a few sectors and businessmen will do nothing to alleviate these problems. Instead the government should be looking into investing the allocated sum to reduce these hurdles for exporters. It will eventually make our exports competitive and might increase both exports volume and revenue.

Another reason why cash incentives will not increase exports earnings (share of GDP) is that it will not address the underlying cause for eroding export competitiveness at the first place: Supply side constraints such as poor infrastructure network, lack of reliable and adequate power supply, excessive labor unionism and militancy, lack of raw materials needed for our firms, and very few opportunities and avenues, on top of bureaucratic red tapes, for new entrepreneurs to enter the market.

Exports incentives should be wisely designed and implemented to address some of the supply side constraints and to enhance productive capacities of the export-oriented firms. Cash incentives to be reaped by few firms and businessmen will not address the main reasons why our exports are losing market pie in the increasingly competitive international market.

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[Published in Republica, July 10, 2011. P.6]

Political instability and economic growth in Nepal

Here is Prem Khanal’s take on the relationship between political instability and economic growth. Here is what I argued about frequent political change (democracy and autocracy only-- not political instability) and growth.

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Political instability saps economic growth

PREM KHANAL

Nepal´s economic growth rate slid to 3.5 percent this year, the lowest in the last three years, raising a pertinent question: Is this poor performance linked to our political instability?

Analyses of Nepal´s growth data for the last 20 years and the political situation clearly indicate that the economy and politics are intricately linked and economic growth and political stability have a strong positive correlation. 

The major political changes and election of majority governments are always followed by robust economic growth. Likewise, political instability and hung parliaments often lead to weak performance by the economy.

Nepal attained high economic growth of 7.9 percent in fiscal year 1993/94, following the election of a majority government under the leadership of the Nepali Congress in the first general election held after Jananadolan-I. During the subsequent three and half years under NC rule, the economy grew by 5.3 percent on average.

However, the mid-term election held in November 1994 produced a hung parliament and the CPN-UML took leadership of a minority government. Nepal´s first communist government, which was headed by Manmohan Adhikari, lasted only nine months. The country then saw four more governments in as many years, led in turn by Sher Bahadur Deuba, Lokendra Bahadur Chand, Surya Bahadur Thapa and the late Girija Prasad Koirala.

During these years of political instability the economy teetered. The average growth rate in those five years was hardly 4 percent and in fiscal year 1997/98 it dipped to 3.3 percent.

The general election held in May 1999 once again produced a majority government led by the Nepali Congress and the economic growth rate bounced back to 6.1 percent in 1999/2000 and remained relatively high at 5.4 percent the following year.

By the end of the 1990s the Maoist insurgency has begun to peak and economic growth again started to falter. The year 2001/02 saw the highest single-year insurgency toll of over 5,000 and not surprisingly the economic growth rate sank to 0.16 percent and the economy was in the doldrums in successive years.

The growth rates remained pessimistic, averaging slightly over 3 percent, even during the king´s 15-month direct rule.

The success of Janaandolan-II that humbled the king´s rule and ended the insurgency provided an immediate boost to the economy. It grew by over 5.8 percent in 2007/08.

As the Janandolan euphoria gradually receded and political uncertainty crept back, the economy started to falter again. In the last three years economic growth rate has slid steadily, culminating in this year´s 3.5 percent.

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Nice article. It would be even more revealing if we look at growth rate, political instability, and investment rate/capital formation. The reason is that the fruits of some investment projects is seen after some years of inception or completion. The effects are not immediately visible. For instance, during FY 2059/60 budget, the then finance minister Dr. Ram Sharan Mahat pumped in large amount of money into infrastructure projects. I think its positive impact helped sustain growth (though low) rate during the insurgency period. Without the investment it would not have been possible to sustain even that low growth rate during the insurgency period. Al least, local economies remained buoyant during insurgency as well. A lagged effect (few years) of capital expenditure/formation might reveal a truer relationship.

More on remittances study in Nepal by the WB

This blog post supplements an earlier detailed blog post about a recent report (forthcoming) based on Nepal Migration Survey (NMS) 2009. After reading the presentation slides I had summarized the main points and put forth my comments on few issues, especially regarding the exact estimates and Dutch Disease effect of high remittance inflows. A detailed summary now addresses these concerns in detail. (Still waiting for the full report).

• On the estimates of number of migrants, the NMS shows there are 2.1 million migrants, particularly in India (867000, 41%), the Gulf countries (810000, 8.7%), Malaysia (245000, 12%), and other developed countries (186000, 8.7%). Meanwhile, other estimates put the number of migrants to India between 1.5 to 3 million. The study notes that this discrepancy might be because the survey was carried out at the peak of farming season (May-June), when many migrants return home from India to work on the farms. [The number of non-work migrants, mostly with student visas, is estimated at 1.2 million.]
• The survey estimates that foreign remittance in FY 2009 was US$ 2.5 billion (20% of GDP). Excluding flows from India, remittances amount to 16% of GDP. The NRB’s estimate of total remittances for the same fiscal year was US$ 2.7 billion (22% of GDP). Earlier, WB’s Migration and Development Brief 13 estimated it to be US$ 2.986 billion. [If you include remittances flowing in via informal channel, then it might go well beyond 25% of GDP.]
• Of the US$ 2.5 billion, US$ 1.2 billion came from the Gulf, US$ 530 million from other destinations (21%), US$ 467 million from India (19%), and US$ 260 from Malaysia (10%).
• Internal migrants sent about 2% of GDP.
• The report notes that symptoms of Dutch Disease effect are seen in the economy (not outright Dutch Disease effect due to remittances) due to high consumption demand, high imports, and appreciation of real exchange rate (due to increase in the price of nontradables with respect to the price of tradables), and erosion of manufacturing sector and its competitiveness.
• Migrants destination vary according to wealth status. Households with least wealth go to India but its attractiveness declines with increase in wealth. In other developed countries, migration increases as wealth and education level goes up. In Malaysia, migration goes up as wealth goes up and peaks at the fourth wealth quintile before declining to the wealthiest quintile.
• Ethnically, the probability of migration, in descending order, is above average for Muslims/others (mainly to the Gulf), Hill Dalits (mainly to India), Hill Janajatis (mainly to the Gulf), and Brahman/Chhetri (to all India, the Gulf and Malaysia).
• Migrants are abroad are mostly employed in manufacturing (32%), construction (16%), and hotel/catering (16%).
• Per capita receipt of remittances generally increases with recipients’ household wealth (skilled and educated migrants send more).
• Western Hills and Eastern Terai receive the most remittance. The Western Hills sends the largest number of migrants (20%). For Eastern Terai the number is 17%.
• Returnees generally come back to agriculture and inactivity. Some go to “others” category, indicating a slight increase in entrepreneurial activities and acquired skills. Meanwhile, returnees choose occupation similar to those they held before migration. A returnee who was active before migration is 17.5 percentage points more likely to remain active upon return (this after controlling for a “full” set of observable characteristics).
• “Real” returnees, those that are not likely to migrate, are involved in more professional and entrepreneurial activities.
• In FY 1996-2004, poverty decline from 42% to 34% and more than half of this was attributed to remittance. The survey analysis showed that between FY 2004-2010 (but the survey was completed in 2009??), the poverty incidence declined to 21% due to increasing remittance (in the absence of remittances, poverty would have declined to 27%, according to the study).

Read the summary and this blog post for more details. For even more details, wait for the full report to be released.

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Below are some of the charts from the report.

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How large is the government spending multiplier?

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This paper proposes a novel method of isolating fluctuations in public spending that are likely to be uncorrelated with contemporaneous macroeconomic shocks and can be used to estimate government spending multipliers. The approach relies on two features unique to many low-income countries: (1) borrowing from the World Bank finances a substantial fraction of public spending, and (2) actual spending on World Bank-financed projects is typically spread out over several years following the original approval of the project. These two features imply that fluctuations in spending on World Bank projects in a given year are in large part determined by fluctuations in project approval decisions made in previous years, and so are unlikely to be correlated with shocks to output in the current year. World Bank project-level disbursement data are used to isolate the component of public spending associated with project approvals from previous years, which in turn can be used to estimate government spending multipliers, in a sample of 29 aid-dependent low-income countries. The estimated multipliers are small, reasonably precisely estimated, and rarely significantly different from zero.

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More by Aart Kraay here.

Nepal’s policies and programs for 2011-2012 (FY 2068-2069)

The Ministry of Finance has released Nepal’s policies and programs for the next fiscal year starting July 16, 2011 and ending July 15, 2012. The fiscal budget in the past three years have come late. It stresses that real change can only happen through economic prosperity, which can then sustain the political gains achieved so far. See my brief comment at the end of the summary of the document. I will write a detailed one later on.

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Major priorities:

• Peace process and constitution writing to be high priority.
• Socio-economic transformation through high economic growth, controlling inflation, just distribution of the fruits of growth with a view of reducing poverty and inequality, inclusive development, increase employment, and production and productivity increase in agriculture and industrial sectors.
• Prioritize those projects that yield fast return; accelerate completion of ongoing infrastructure projects
• Allocate enough resources to implement the programs outlined when the government announced energy crisis
• Promote cooperatives to utilize unutilized personal, natural and economic sources
• Priority to increase capital accumulation and productive capacity
• Improvement in services delivery and governance
• Programs aimed at women, indigenous communities, and marginalized groups and communities.

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Economic appraisal (till Baishak 2068—May 14 2011-- of the fiscal year):

• GDP targeted at 4.5% but will be only 3.5-4%. Performance of non-agricultural sector is below expectation.
• Inflation targeted at 7% but will be above 10%.
• BoP deficit is around Rs 11 billion.
• Total exports amounted Rs 52.67 billion, but total petroleum imports amounted Rs 59.53 billion.
• Foreign exchange reserves can sustain 7.1 months of imports.

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Upcoming budget and principles

• Public, cooperatives, and private sectors to be the foundations of economic prosperity.
• To be focused on Interim Three Year Plan, particularly employment focused and inclusive growth.
• Relief package to civil war victims, martyr, and disappeared households.
• Agriculture sector to be commercialized and modernized.
• Supervisory, governance and facilitator roles to be strengthened.
• Cooperatives to be a solid foundation of the economy. Marginalized communities and groups to be promoted thorough cooperatives.
• Special efforts to enhance confidence of private sector and to create investor friendly climate.
• Big infrastructure projects to be prioritized. Private sector to be encouraged to participate through BOOT principle.
• Concessions to be given to investors investing in energy sector.
• Import substitution for petroleum imports by promoting alternative sources of energy.
• Take advantage of rising neighbors—India and China—by accelerating expansion of infrastructure, industry, service, and trade sectors.
• Budget deficit to be limited within a certain limit. Unproductive government expenditure to be curtailed and capital expenditure to be increased.
• Implement monetary policy to curb rising prices. Public goods delivery system to be structured and carteling to be banned.

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Policies and programs of the upcoming budget

• Budget to implement comprehensive peace agreement and constitution making.
• Relief, reconstruction and rehabilitation of martyrs and disappeared people and destroyed infrastructure.
• Ease public service delivery system: food security in rural areas, decrease in power outages, normal supply of petroleum products, proper management of  urbanization in Kathmandu valley, water supply and traffic jam.
• Employment focused inclusive high economic growth: additional labor intensive economic activities, vocational training, youth self-employment program, foreign employment, channeling money into productive sectors
• Physical and economic infrastructure development: roads network to be expanded, rural infrastructure, all district headquarter to be linked by roads within two years, Mid-Hill highway to be opened by 2069, accelerate work on Kathmandu-Terai Fast Track highway
• Electricity generation and transmission line expansion: accelerate ongoing works, promote small and medium sized projects to increase supply in short and medium term, expansion and repair of transmission lines, reduce electricity leakage, rural electrification, Energy Development Bank to be established, reform of NEA
• Commercialization and modernization of agriculture: food security, employment, exports, import substitution to be the focus; commercialization of self-reliant agriculture; increase subsidies in fertilizer, seeds and supply; establish agricultural farm with the help of cooperatives; ‘one village, one product’ program to be launched as; livestock development; herbs farming in all development regions
• Land reform; expansion of irrigation facilities
• Cooperatives development and expansion: launch ‘cooperatives in every village, employment in each household’ as national program; livestock development; meat and fish products focus; herbs production and processing; vegetables and fruits farming;
• Social development: education, health, water supply; primary health care to be made free gradually, health insurance to be launched, primary education to be made mandatory (gradually); water supply to all citizens
• Tourism development: infrastructure development, training in this sector; NTY 2011 to be prioritized and effectively implemented; second international airport in Nijgarh, Bara under BOOT principle; upgrade existing airports
• Private sector development, investor friendly climate and industrial revival: attract private sector investment to stimulate high economic growth; investment security, illegal trade, and investor friendly taxation regime to be addressed; resuscitation of sick industries and industrial peace;
• Export promotion and import substitution: special programs to be launched to increase exports and encourage import substitution; incentives (cash and others) given for export promotion to be systematized and further encourage exporters; pass law regarding SEZs
• Rural infrastructure and model village: at least one model village in each district (all facilities and infrastructure to be provided)
• Various party related pet projects (afno gaun, afai banau) to be made effective by addressing shortcomings
• Rural focused programs: Continuity to ‘one household, one employment’ program in Karnali; marginalized groups and communities focused programs
• Communication: increase access to communication (TV, telephone, radio, and internet); accelerate laying of optical fiber in rural areas
• Financial sector reform and increase financial penetration: special program to resolve liquidity crisis; enhance regulatory and supervisory roles; encourage merger; increase financial penetration in rural areas; deposit insurance of small depositors
• Foreign aid: effective mobilization of foreign aid; no aid to be accepted without compliance with the government’s rules and regulations
• Fiscal stability: limit budget deficit within a limit; enhance capacity of revenue department by establishing Revenue Board; increase tax base, decrease leakage, administrative reform; 

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Comment: Seriously, there is no concrete agenda and acknowledgement of the major economic problems—low economic growth and high youth unemployment, surging trade deficit, BOP deficit, high and sticky inflation, liquidity crisis, slump in manufacturing sector, proper management of remittances and foreign employment sector, and disruption in supply chains– faced by the nation. The binding constraint to economic growth, i.e. infrastructure is not getting adequate and specific attention, though some long term programs in expanding road network is mentioned.

Most of the programs on employment will yield little result as they are designed to distribute money to party loyalists and local contractors that are faithful to a given party. Cooperatives in everything and in every village is a joke of the very concept of having cooperatives in the first place. It will actually legitimize doling out easy money to loyalists in every VDC. The role of private sector is very minimal in the whole list. Importantly, there is no mention of the fact the Nepali economy is seeing manufacturing slump and without it sustainable growth and employment are unimaginable. I have very little confidence that the budget will address the major economic challenges faced by the nation.

The size of the budget and expenditure programs are ever-increasing. The expected size of the budget is around Rs 385-390 billion (up from Rs 337.9 billion last fiscal year). Development budget (capital expenditure) is expected to be Rs 150 billion  (up from 129.54 billion last fiscal year). Recurrent expenditure is expected to be Rs 210 billion (up from Rs 190.32 billion last fiscal year). The government plans to mobilize about Rs 246 billion in revenue, Rs 75 billion in foreign grants, Rs 26 billion in foreign loans and about Rs 35 billion in domestic borrowing to finance the next fiscal year´s spending. The figures were Rs 216.64 billion, Rs 65.34 billion, Rs 22.23 billion, and Rs 33.68 billion last fiscal year. Education sector (Rs 61 billion) will get the highest amount, followed by infrastructure (Rs 44 billion), local development (Rs 43 billion), and health sector (Rs 25 billion).